The great milk shake-up

Geoff Taylor

City dwellers and other non-farming New Zealanders will get their first chance to buy into dairy giant Fonterra next month. Dairy Equity, which is seeking up to $100 million for its Fonterra investment scheme, will list on the stock exchange - allowing investors a "low-risk" stake in the co-operative's growing success.

They won't be direct Fonterra shareholders - only the dairy farmers who supply the co-op can own shares in it. They must hold one share for each kilogram of milk solids they supply.

Dairy Equity will use the money it raises to pay farmers cash in a swap agreement giving it beneficial rights for some or all of their Fonterra shares.

With $100 million, Dairy Equity would have a "de facto" stake in Fonterra of about 1.25 per cent, based on the co-op's capitalisation of $8 billion.

Geoff Taylor, managing director of Dairy Equity's management company, says it is possible more floats may take these figures up to about $400 million and 5 per cent.

One of New Zealand's largest fund managers - Taylor won't say which one - is to take a "cornerstone" stake in Dairy Equity.

He said several institutions had expressed strong interest but Dairy Equity could also be attractive to small private investors wanting a low-risk investment.

Late yesterday, Dairy Equity said it would seek $80 million from the offer, which opens on Monday, with provision for over-subscription of a further $20 million.

It was originally going to seek $50 million with provision for $50 million of over-subscription - but the amounts changed after more indications of support for the float.

Taylor said: "People tell us there is a lot of cash about and what we're doing is promoting a low-risk investment. So, to the extent that contrasts with some failures at the high-risk end, it's got to be nice timing."

Any cash not immediately used for buying an interest in Fonterra shares would be invested in blue-chip bank or Government securities.

In return for the cash, Dairy Equity will take the portion of farmers' annual Fonterra payout which comes from the value-added component of the business and any capital gains made when the farmer disposes of shares. The value-added portion relates to Fonterra's returns from areas such as its consumer brands business.

The Dairy Equity scheme gives farmers the chance to get cash for immediate use, without having to surrender their right to supply Fonterra or vote.

Taylor said larger Fonterra shareholders and professionals advising farmers had shown interest in the scheme. There would now be more direct marketing of the scheme to farmers.

Investors in Dairy Equity would get a slice of Fonterra's value-added business and share price capital gains.

"We'll be expecting to pay out 100 per cent of Dairy Equity's net profit as dividends," said Taylor.

Dairy Farmers of New Zealand chairman Frank Brenmuhl said the scheme gave farmers financial flexibility without threatening Fonterra's co-operative structure.

Fonterra has declared itself neutral over Dairy Equity's plans.

Taylor said Dairy Equity had talked to Fonterra and its shareholders council before going ahead with the float and, if they had appeared opposed to the idea, "we just wouldn't have run with it".

In June, Fonterra strategy and growth director Graham Stuart said such a scheme would simply be an addition to a range of outside financing arrangements farmers could make involving their shares. Fonterra wanted to help farmers have "the most liquid set of arrangements with their chosen financiers". A co-op spokesman said yesterday that position had not changed.

Taylor - Fonterra's manager of corporate finance from 1998 to 2002 - looks set to use the Dairy Equity platform to push Fonterra towards a better performance in its value-added business.

He said Fonterra was now at a point where it could begin to assume risk more aggressively on behalf of shareholders.

"We think the business is good enough that the opportunities they've got mean that by taking more risk that will allow that value-added component to grow."

Total returns to Fonterra shareholders - a combination of the value-added portion of the payout and share-price gains - had been running at more than 10 per cent a year.

That estimate was based on Dairy Equity's retrospective calculation of gains, adjusted to take into account a capital restructuring at Fonterra this year.

Usually, sharemarket investors could expect a return of about 12 per cent a year, while Fonterra's valuer had said the implied long-term return on the co-op's shares should be 8.5 per cent.

That 8.5 per cent estimate indicated how "low-risk" the co-op was as an investment.

"I think shareholders, Fonterra and the general public would expect to get a higher return, and so would we," Taylor said.

Dairy Equity will scrutinise Fonterra's business closely and encourage other shareholders to support increased investment in value-added operations.

But Taylor said he was not setting out to rattle Fonterra's cage.

"We think Fonterra, their strategy and what they're doing, is very good. We want to provide support for that and encourage debate that we don't think has been happening sufficiently among shareholders."

He had been disappointed Fonterra missed out on National Foods as it would have been a "fantastic insert" into the co-op's value-added business. Dairy Equity might make its views known if Fonterra was involved in another bidding war.

Some farmers have also called for a better value-added performance and Fonterra CEO Andrew Ferrier said last month the co-op had ambitious targets in this area.

But Taylor said shareholders were not aware enough of what they owned and so were not demanding enough from the value-added performance.

There were dangers in taking extra risk but it was clear Fonterra was not taking enough risk.

He predicted significant growth in value-added returns could lead to a change in Fonterra's capital structure.

There have been calls for the dairy industry to have a milk share, covering the commodity part of the business, and an investment share covering value-added, although some in the industry felt this would open the value-added business to outside investors.

But Taylor said it was worthwhile to debate what "different ownership instruments" might emerge if value-added performance improved.

Fonterra is examining a split of its milk and value-added payments to farmers.

The value-added money would be paid in instalments during the season.

It hopes to announce details of any change early next year. A spokesman said the matter was being considered for "shareholder clarity" and was unrelated to Dairy Equity.

Taylor said his own firm, GT & Co, had no plans for similar investments in other farmer co-operatives but did not rule out the possibility.

The idea for indirect investment in Fonterra came from the Dairy Investment Fund. Its shareholders include Taylor and National finance spokesman John Key.

Taylor said DIF was not investing in Dairy Equity but would continue to operate in the private equity field.


The offer

Opens Monday, closes September 8.

80 million ordinary $1 shares being offered, with provision for over-subscriptions worth $20 million.

No public pool - retail investors must approach brokers with allocations.

NZX trading due to start on September 14.

DEL says it cannot make a meaningful forecast of shareholder returns because that will involve predicting factors outside its control.

Based on historical performance, it is estimated that total returns to Fonterra shareholders - on a combination of the value-added portion of payout and share price gains - have been running at more than 10 per cent a year.